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Risk profile

Relative to the Khmer Rouge years of 1975-79 and even afterwards, Cambodia is now a much stabler and safer country with which to do business. In place of the previous totalitarianism, wholesale bloodshed, economic and financial collapse, and autarky, there is now democracy of sorts, peace, law and order, economic recovery, and trade and investment liberalisation. As the consulting firm Oxford Analytica notes, ‘Cambodia's rehabilitation from a country ruined by war to one of modest prosperity, within a decade, is seen as one of the international community’s more successful interventions.'

Even so, a high risk of external debt default remains. The high risk is due to poor revenue collection (< 12% of GDP) and correspondingly large fiscal and external current account deficits (4% and 10-11% of GDP respectively, in 2006, before official transfers). These deficits need to be financed by foreign aid. Over 1991-2005, Cambodia received more than US$5b in aid and soft loans, making it one of the world's highest per capita recipients of aid. An aid cutoff would spell almost immediate financial distress.

Political instability compounds the risk. Despite the overthrow of the Khmers Rouges in 1979, and the holding of free parliamentary elections in 1993, Cambodia continues to be dogged by political instability and violence. The 1980s saw civil strife as the Vietnamese-backed government fought the allied armies of Norodom Sihanouk, the Khmers Rouges and others. In the 1990s the Khmers Rouges continued to fight a low-level insurgency. Since 1993 the one time-Khmer Rouge cadre Hun Sen and his Cambodian People's Party (CPP) have regularly undermined the country's democratic system through ballot-rigging, harassment of opposition parties and the press, assassination, and even a bloody coup in 1997. So far the international community has been reluctant to impose sanctions to discourage such behaviour out of reluctance to admit that the country’s UN-assisted transition to democracy has been less than smooth. But its patience has limits.

Besides poor revenue collection, aid dependence and political instability, another negative is weak public expenditure management. Inadequate budgetary allowance is sometimes made for aid projects. And government payment arrears are a problem, with the stock of outstanding arrears large, according to the IMF.

Risk outlook

The outlook is positive thanks to prudent economic policies supported by an IMF program. These have checked inflation, stabilised the exchange rate and put the external debt/GDP ratio on a downward track. They have also supported the textile, garment and tourist industries, enabling real GDP growth to average 7¾ % pa over 1999-2004. Better yet, growth is expected to average at least 6% pa over the next five years. Though the expiry of the Multi-Fibre Agreement is putting pressure on the garment industry, and high world oil prices are exerting a further drag, prospects for telecoms, tourism and construction are bright. As a reward for its achievements, the IMF recently granted Phnom Penh 100% debt relief under the Multilateral Debt Relief Initiative – a write-off of US$82m.

It is not inevitable, however, that the risk profile will improve. Political instability in and of itself could be a problem. It could also hurt the country indirectly – by setting back economic management and debt consolidation.

Recent risk developments

Since last October, Prime Minister Hun Sen has been intensifying his crackdown against opponents. There has been a wave of arrests of human rights activists in particular. Earlier in the year, the government stripped opposition leader Sam Rainsy of his parliamentary immunity from prosecution in preparation for charging him with defamation; this forced Rainsy to flee the country. The effect of these steps has been to muzzle debate and opposition.

For the time being, this won't necessarily prompt sanctions. Some foreign governments have issued warnings, but the IMF nonetheless announced that it would cancel all pre-2005 credits to Cambodia on 22 December– the day Rainsy was sentenced to gaol. An alternative to aid suspension would be a halt to Cambodian garment imports, but this would threaten the livelihoods of up to 300,000 people, something Western governments would be reluctant to do. For his part, Hun Sen, probably as a result of international pressure, announced on 24 January that he would drop defamation charges against several activists.

Still, if the government extends its crackdown, there could be instability and an eventual aid suspension. There are concerns that Hun Sen has decided to take the road of the Burmese military junta – that having neutralised NGOs, he will now move on to unionists and others. Such a move could be the trigger for both civil strife, especially in the lead-up to elections scheduled for 2008, and sanctions – foreign governments imposed sanctions following the 1997 coup.

Benchmarking Cambodia

Neither the OECD, nor the international credit rating agencies, rate Cambodia.

Cambodia scores poorly for ‘governance’, corruption, political rights and civil liberties.

World Bank governance indicators show a country in the bottom quartile of the international league table on five out of six indicators (see chart). More happily, the country has been improving since 1998 on all counts except rule of law, where it has gone backwards.
International corruption watchdog Transparency International ranked Cambodia 130 out of 158 countries in 2005 for ‘perceived levels of corruption, as determined by expert assessments and opinion surveys’ – alongside Burundi, Congo Brazzaville, Georgia, Kyrgyzstan, PNG and Venezuela.
Freedom House classes Cambodia ‘Not Free’, with a score of 6 for political rights and 5 for civil liberties on a scale of 1 (freest) to 7 (most repressed). It says that the trend is upward ‘due to a new coalition government that put an end to a year-long political stalemate’. It wrote this, however, before the most recent authoritarian relapse.

Cambodia's best marks come for economic freedom. The Heritage Foundation classes the country as ‘Mostly Free’ on this score. The country ranks 68 out of 157 countries – ahead of even Malaysia and Thailand.

Breach-of-contract risk – High

The legal and judicial system does a bad job of protecting property rights and enforcing contracts. According to the US Department of Commerce, there are frequent problems with inconsistent judicial rulings and outright corruption. Cambodia has no commercial arbitration code. In 2001, it passed a law implementing the New York Convention on the Recognition and Enforcement of Foreign Arbitration Awards. Even so, the ability of Cambodian courts to enforce decrees is limited.

The regulatory system is also opaque and the legal framework for a market economy incomplete. Conspicuous by their absence are company and commercial arbitration laws, still to be passed by the legislature. Corruption is widespread, with civil servants routinely relying on bribes to supplement scanty wages. However, there is no pattern of discrimination against foreign investors in Cambodia through the regulatory regime, according to the US Commercial Service.

Inconvertibility risk – Moderate

While the riel is currently freely convertible for both current and capital account transactions, the economy’s vulnerability to external financing problems could result in convertibility being restricted in future. The government has accepted the IMF's Article VIII (providing for current account convertibility) and also imposes few capital controls. Moreover, the US Embassy in Phnom Penh says it is not aware of any cases of investors meeting obstacles in converting local to foreign currency or in sending capital out of the country. Then again, the Foreign Exchange Law does allow the National Bank of Cambodia, the central bank, to impose exchange controls in a crisis.

Asset damage risk – Moderate

Cambodia is prone to sporadic civil unrest which can result in damage to business. Factional fighting in 1997 resulted in damage to business from looting and gunfire; the government is still considering whether to compensate for the damage. Up to 17 Thai businesses suffered damage during anti-Thai rioting in Phnom Penh in January 2003. The Cambodian government has pledged to compensate unconditionally and has paid some compensation to the Thai government and Thai businesses, but the two countries continue to negotiate. Up till 1998, the Khmers Rouges presented a threat, but since their disbandment in that year, no longer do.

Expropriation risk – Low

Cambodia's constitution and laws provide strong protection against expropriation without compensation. Article 44 of the Cambodian constitution says that ‘the state’s right to confiscate properties from any person shall be exercised only in the public interest as provided for under the law and shall require fair and just compensation in advance.’ The Law on Investment provides that the government ‘shall not undertake a nationalisation policy which adversely affects the private property of investors.’ The law provides for an open and liberal investment regime with national treatment of foreign investors. Foreign ownership is restricted in only a few areas, eg land (barred) and publishing, printing and broadcasting.

Roger Donnelly
Chief Economist
rdonnelly@efic.gov.au

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